DEALMAKER GUEST BLOG -- JAMES L. RENCH

General advertising is in, but so, too, are new restrictions

Blog Entry: September 25, 2013 4:30 AM | Author: JAMES L. RENCH

James L. Rench is a partner in Stark & Knoll's Business Services Group. He practices in general corporate, corporate transactions and commercial lending, and has been advising on mergers and acquisitions for more than 35 years.

On July 10, 15 months after enactment of the JOBS Act of 2012, the Securities and Exchange Commission adopted regulations mandated under the JOBS Act, relaxing the long-standing prohibitions against general solicitation in the offering of securities in exempt private placements. Under the new regulations, effective this past Monday, Sept. 23, and codified at Rule 506(c) of SEC Regulation D, the previous requirements of a pre-existing relationship with a prospective investor and the prohibition on general solicitation no longer apply.

Also on July 10, the SEC adopted new Rules 506(d) and (e) and changes to Form D that make all Rule 506 offerings subject to certain “bad actor” disqualifications, disclosure and certification requirements.

And finally, the SEC has proposed for adoption a suite of amendments to Regulation D, Form D and Rule 156 that are intended to enhance the SEC's ability to monitor market implementation of the new private offering regime and provide investor safeguards in connection with general solicitation and advertising.

The new rules under Regulation D, both adopted and proposed, represent a dramatic shift in the regulation of private securities offerings, and open new opportunities for companies seeking to raise capital. And while the revised private offering process under the new rules may be less restrictive in certain respects, the sale of securities in private transactions remains a highly regulated activity requiring careful attention to state and federal regulatory schemes, some of which are still evolving.

While it lifts the general solicitation ban, new Rule 506(c) imposes on the issuer of the securities the duty to verify that the purchasers in the offering are accredited investors based on net worth or annual income. This will put the burden on issuers and their representatives to develop appropriate methods of verification and to retain adequate records of the steps taken to verify the accredited status of each purchaser in an offering.

The rules do provide some guidance to issuers by providing a non-exclusive list of verification methods applicable to natural persons, including reviewing tax filings, bank statements, brokerage statements and credit reports, and obtaining written confirmation from third parties (such as registered broker-dealers, registered investment advisers, accountants or attorneys) that the purchaser qualifies as an accredited investor. The likelihood that potential investors will be reluctant to share such confidential financial information with issuers is likely to cause third-party verifications to become the predominant method of verification.

The newly adopted Rule 506(d) disqualifies an offering from exemption under Rule 506 if the issuer of the securities or other persons related to the offering (such as underwriters, placement agents, or the directors, officers or significant shareholders of the issuer) have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws (the so-called “Bad Actor Prohibitions”).

Rule 506(d) puts the burden on issuers and their representatives to undertake careful due diligence of each group of persons covered by the Bad Actor Prohibitions in order to establish that they did not know, and in the exercise of reasonable care could not have known, that a disqualification existed under the rule.

Under the proposed revisions to Regulation D, an issuer in a Rule 506(c) offering would be required to file a pro-forma Form D at least 15 days in advance of making a general solicitation and file an amended final Form D within 30 days after termination of the offering, and include specific legends on any written general solicitation materials.

In addition, and for an initial temporary period of two years following adoption, the proposed Form D rules would require issuers to submit written general solicitation materials to the SEC no later than the date of their first use. Failure to comply with the new Form D rules would preclude an issuer from relying on Rule 506 for a period of one year following a curative Form D filing.

The net effect of all the restrictions and conditions contained in the amended and proposed amendments to Regulation D private offerings may well be to undermine their usefulness to the very small business issuers intended to benefit from the amendments.

As a practical matter, the cost of compliance with the new rules may well cause such issuers to reconsider their initial enthusiasm for a broadly advertised offering and, instead, opt for a traditional “old school” closed offering to friends and pre-existing contacts. And the consequences of non-compliance — a non-exempt offering in violation of the securities laws and a “bad actor” ban from utilizing the private offering exemption in subsequent offerings — may simply be too disastrous to risk.

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